Developers may have to pay the price for holding on to inventory

Some developers are now offering enhanced payment options to investors. (EB FILE)

By

Anjana Kumar

PublishedSunday, March 08, 2009

Developers, who held back inventory to sell on project completion, are likely to incur a number of costs such as interest on bank loans, dues to suppliers and contractors and other overheads, according to experts and developers. However, developers can minimise the costs by selling their units with flexible payment options for the buyers.

"The costs of holding inventory can range from service charge payments to master developers and even bank charges for construction loans. Although I cannot quantify the costs, there is definitely a charge to the developer for just holding on to the units," said Walid Jaafar, Partner, Fichte & Co Legal Consultancy. If developers do not find enough buyers for their projects, they would have to look for other sources of financing, either from banks or private investors, in order to be able to complete their projects and meet the deadlines.

"It will be difficult to find banks willing to extend loans these days. And if loans are not extended, developers will have difficulty in fulfiling their contractual obligations with buyers and fail to deliver the promised property. This, of course, will lead to them being in default of their contractual commitments and may entail legal prosecution by all concerned – be it the buyer, contractor, supplier or other parties – for the recovery of their money. Such legal pursuit may lead to the bankruptcy of the developer, in the absence of necessary funds to cover these claims," said Jaafar.

According to Markus Giebel, Chief Executive of Deyaar, there is both a cost and a loss for developers who have decided to hold on to units.

"There is obviously a cost incurred by the developer in developing the unit and then maintaining units that are vacant. There is also an added loss in this case, since there is no return on investment. In theory, there are opportunity costs and potential losses associated with developing projects that are unsold, or partially unsold," said Giebel.

"Quantifying potential losses across projects and developments is not possible for developers at this stage. Quantifying the potential losses for properties not put up for sale will vary from case to case, from developer to developer. We have adjusted our product portfolio and aligned resources to eliminate such a risk. We remain in a healthy cash position to fulfill its commitments. We are still receiving payments from clients for our existing projects under construction," he said.

Mohammed Nimer, MAG Properties' Chief Executive, said developers would not only incur losses but also a delayed return and capital gain. "Developers have already lost out by 20 to 25 per cent of their profitability because of an increase in construction material prices. They are just accepting this at the moment," said Nimer.

According to Rajesh Kumar Krishna, Managing Director, Indiana Real Estate, the biggest challenge today in the market is whether property purchasers will be able to complete their payments to developers as per schedule. "We think, a number of property buyers should have either cancelled or downsized their purchases owing to the market situation," said Krishna.

"Prior to the slowdown, most of these units would have been sold, but given the global liquidity crunch and suspension of mortgage finance by many banks, many buyers in the market will find it difficult to repay their loans," said Krishna.

He said property prices have come down over 40 per cent in just the last seven to eight weeks and we may see it falling by another 10 to 15 per cent this summer. Rentals have dropped steeply as well.

Giebel said Deyaar does not have any units left in their projects to sell, or any projects that are ready for handover. "We have not experienced any defaults so far, and there are no units coming back to us, despite the financial crisis," he said.

Deyaar recently announced that it would deliver seven projects this year, including 'The Citadel' and 'Hamilton Residency' in Business Bay. Other Deyaar projects to be delivered this year include Madison Residency in Tecom and four projects in the Silicon Oasis.

"All these projects have been fully sold out with all units committed. While it is difficult to predict the number of occupants within the units, we do expect a high level of occupancy as the market is characterised by demand for completed properties in premium locations such as Business Bay, where the majority of our projects are," said Giebel.

The developer recently announced that it was focusing on adjusting its portfolio and aligning its resources by holding back 25 per cent of its portfolio, which is unannounced and not released for sale so far. The developer is also considering a consolidation to projects that will be completed on a fast track basis, a strategy it has adopted order to safeguard the interest of its customers.

According to Jaffar of Fichte & Co, a large number of properties that will be put on the realty market in Dubai have been bought for speculative purposes and are not intended for end-users.

Meanwhile, Dubai developers have been adopting different strategies in order to stay with the pace of the real estate sector. "Since the crisis started from June-July last year, the real pinch and heat was felt just after Cityscape, and now most developers will come to this consensus that whatever they have launched they will build but will not launch anything new for the moment," said Nimer.

Nimer said that today, the more developers have left to sell the more they are in trouble. According to him, there are 30 units left to sell in MAG 218.

But Deyaar is offering enhanced payment options to its investors. Giebel said: "For us, the risk of vacancies is negligible. Deyaar is also offering its customers and investors enhanced payment options to benefit from more flexible repayment terms. In case of any default, which of course is the least likely resort for the buyer, leasing the properties could be considered as an option to offset potential losses from vacancies. We are developing different strategies to safeguard our customers, such as soft payment schedules and partial price reductions, which are expected to result in no or very limited defaults."

Deyaar's chief executive said the decision by individual developers to raise a leasing portfolio would depend on the demand and supply dynamics of the rental market for residential and commercial properties, which in turn would define the returns.

"If the demand and supply balance is favourable, then developers could consider leasing as an option. We believe the fundamentals in the UAE market are strong and the real estate sector is well positioned for sustained expansion in the long-term," said Giebel. Deyaar currently manages a leasing portfolio of over 16,000 units.

The developer said it has witnessed a shift from a speculative demand-driven market to an end-user one.

"We believe this is a positive for developers and for the long-term stability and growth of the real estate sector. Going forward, in 2009, we think there will be a significant decrease in speculative buying of properties and more end-users will enter the market, which is the real market that developers should be aiming for," said Giebel.

Companies that will shift from trading to long-term investment business models are expected to sustain strong growth trends through the crisis. Price "cooling" in Dubai is a fact but a severe crash is unlikely if demand constraints in terms of buyer financing begin to ease. Dubai, the UAE and the wider region remain strong in their fundamentals, a growing economy and strong demographics, encouraging long-term sustainable growth, Giebel felt.

Ahmed Shaikhani, Managing Director, Memon Investments, believes it is likely there will be an oversupply of apartments in the next few years, and non-established areas are likely to suffer bar price reductions.

"Established villa communities, on the other hand, should still be able to generate good revenues on the back of high demand owing to location advantage and the quality of lifestyle they offer. Demand and supply will, in short, balance each other out to stabilise the market. However, I believe affordability is the key determinant that will drive occupancy," he said.

"In my opinion, there are both investors and buyers involved in this market. It is also a well-known fact that most investors in Dubai's property market are from abroad," said Shaikhani.

"At the moment, it is the speculators who are suffering. Those who have sold and resold and made their profits are not able to continue their practice today due to a lack of buyers in the market. Any distress sale at this point in time would result in a loss or a drop in the value of their investment. However, I am optimistic that in another eight months to a year, we should be able to see the market recovering with due price corrections. Owing to the huge liquidity in this part of the world, Middle Eastern buyers can well afford to hold onto their properties for another two to three years."